Deep value, contrarian, and Grahamite investment

Archive for May, 2010

Josh at The Reformed Broker breaks out a chart showing “a blueprint for a potential head-and-shoulders topping formation with either the S&P or the DJIA currently sitting at the neckline.” Here’s the chart:

Josh says the ”right shoulder is coming’ meme will eventually go mainstream.” I’m no chartist, but when I stare at that chart, I have to admit that I don’t see the head-and-shoulders formation. I see something else. I see Batman’s cape:

I remember the old “Bat cape” trade of March ’09. When you see the Bat symbol, get on the right side of Batman.

Exhibitor Reading Int’l – Cashing in on Aussie Land Boom – getting the movies for free.

Movie box office isn’t the only business that’s popping for theater exhibitor Reading International (NASDAQ: RDI) these days. In fact, a resurging property boom in Australia, particularly in Melbourne, is likely to have a greater effect on Reading’s near term market value than Avatar, Alice, Shrek or anything else on the silver screen.

That’s because Reading isn’t just a 466-screen exhibitor that has the 3rd, 4th, and 12th largest share in Australia, New Zealand, and the US, respectively. Reading also owns valuable real estate parcels that have appreciated, in some instances, for over more than a decade, from surrounding population growth, substantial up-zoning, construction, lease-up and, of course, inflation.

It important to note that, at $4/share, the entire company’s market cap is $91MM. Book value, at almost $5/share, is understated for all the appreciation on Reading’s real estate. Extracting the value of Reading’s real estate from its enterprise value imputes a very low—possibly even negative—multiple on Reading’s cinema business. In essence, you buy the land and get the movie business “for free”.

At its recent annual meeting, Reading made a slide presentation filed as an 8-K with the SEC. This presentation besides highlighted 2009’s record growth and an outstanding Q1 2010, illustrated, among other things, how Reading’s EV/EBITDA valuations were already equal to or somewhat less than comparable companies in both industry segments (see pages 7 and 9).

Per Reading’s 2009 10-K, its Real Estate segment is 49% or $197.MM of the company’s assets. These assets include fee ownership of approximately 16.5mm sq. ft. of real estate comprised of 1.2 million sq ft. of cash flow generating commercial real estate, and approximately 15.3 million sq. ft. of land to be developed and built upon in the future. So almost 93% (15.3 sq. ft./16.5 sq ft) of Reading’s real estate assets presently do not yet contribute to Reading’s present $36MM adj EBITDA (LTM March 31, 2010).

The substantial amount of assets carried in Reading’s enterprise value that don’t contribute EBITDA is why the Reading’s recent decision to list for sale its large and unencumbered 51-acre Burwood Square development parcel in Melbourne is a major near-term catalyst that should shed light on Reading’s deep stock market undervaluation.

Purchased by Reading in 1996, the Burwood land has enjoyed almost 15 years’ worth of appreciation due to inflation, surrounding population growth, and substantial up-zoning. Burwood is on Reading’s balance sheet for only $47MM, and represents the largest unrealized gain of any of Reading’s eight major undeveloped parcels, which together comprise 130 acres, have a gross book value of $70MM and don’t presently contribute to EBITDA.

Acquired when it was nothing more than a rock quarry and zoned industrial, Burwood Square is now one of the last prime developable sites fairly close to Melbourne’s central business district. Indeed, the parcel was, until recently, part of a mixed-use development plan that was to include commercial, retail, and entertainment space, and 700-1000 residences.

However, there now appears to be good reason for the parcel to have an increased residential component – perhaps more than 2000 residences. According to an article in a leading Melbourne paper, Burwood-area homeowners are seeing enormous growth from the steady rise in demand caused by housing requirements of nearby Deakin University and an influx of Chinese residents/students. It should be noted that student housing demand is less cyclical than most.

A detailed Information Memorandum (.pdf) (a sales “teaser”) on the Burwood parcel has recently been posted on Reading’s website. The teaser includes some amazing aerial photos clearly showing how Melbourne’s burgeoning population has migrated over the years to completely surround this crown jewel of Reading’s real estate holdings. In addition, the memo sets forth that indications of interest, including buyer’s offer price, conditions and credentials and plans, are to be provided by end of day, June 28 and that Reading will short list its candidates by July 5th.

The sale of Burwood would convert a parcel, which comprises almost ¼ of Reading’s real estate asset book value, and unlock substantial embedded unrealized gain, into cash. Investors ought to more easily reflect the intrinsic value of both of Reading’s business segments after monetizing Burwood and selling or developing other Reading non-EBITDA-generating parcels with a higher stock price.

[Full Disclosure: I hold RDI. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. Do your own research before investing in any security.]

For the past quarter century, equity analysts’ earnings-growth estimates have been almost 100% too high. Their overoptimistic projections have generally ranged from 10% to 12% annually, compared with actual growth of 6% (excluding the spike in growth from 1998–2001), according to McKinsey research. Only in strong-growth years such as 2003 to 2006 did forecasts hit the mark.

Perhaps the most surprising thing to me is the inability of even market professionals to adjust for profit margins. People will talk about how the P/E ratio is reasonable at 19 times without mentioning that it is 19 times the highest profit margins ever recorded. The least we can do, as professionals, is to normalise between economic boom and economic bust, between low profit margins such as those in 1982 when they were ½ normal and very high profit margins such as those of today. A lot of people think profit margins can be sustained. Profit margins are the most mean-reverting series in finance.

BigBand Networks Inc (NasdaqGM:BBND) is interesting activist situation with ValueAct’s small cap fund holding 11% of its outstanding shares. I’d like to talk to someone who knows about BBND and its industry. You can reach me at greenbackd [at] gmail [dot] com.

About BBND

BBND develops, markets and sells network-based platforms that multiple system operators (MSOs) and telecommunications companies to offer video services across coaxial, fiber and copper networks. The Company’s customers are using its platforms to expand high-definition television (HDTV) services and ensure video advertising programming to subscribers. The Company’s Broadcast Video, TelcoTV and Switched Digital Video solutions comprises a combination of its modular software and programmable hardware platforms. The Company sells its products and services to customers in the United States and Canada through its direct sales force. The Company sells to customers internationally through a combination of direct sales and resellers. Its international resellers include Guangdong Tongke, Sugys and Ssangyong, who sell to end users such as Jiangsu Cable and LG Powercom.

Value proposition in summary

BBND’s tangible book value at 31 March was $142M or $2.10 per share (~80% of BBND’s assets are cash and short term investments and it has no debt). It closed yesterday at $2.81, giving it a market capitalization of $190M. The top line has fallen off a cliff, down from $185M in 2008 to $127M in the twelve months Cash from operations has fallen even more precipitously, down from $48.8M in 2006 to $1.4M in the twelve months to 31 March. CapEx has run at $4.9M over the last twelve months and was $4.6M in 2009.

ValueAct Capital [is] one of the elite activist funds, who as a group averaged gains of 144% in companies where they filed 13D forms.

According to the most recent 13D filed 18 May, as at 10 May ValueAct Capital held 11% of BBND’s outstanding capital in its SmallCap Master Fund. BBND released results on 7 May and the stock has fallen 20% since. ValueAct has continued to buy heavily, so clearly sees value at these prices.

Conclusion

There’s plenty of volume in this stock at these prices, so I’d love to talk to someone who understands BBND and the industry. Please get in touch at greenbackd [at] gmail [dot] com.

Value investors are constantly on the look-out for businesses with “moats” that the competition cannot displace. Usually, this is the result of a competitive advantage that cannot be copied. But perhaps it can also be the result of being in a business that is shunned to the extent that no quality management wants to copy it.

Consider New Frontier Media (NOOF), producer and distributor of pornographic movies. The company has deals in place with the major cable providers which allows them to beam millions of dollars worth of adult pay-per-view content into homes throughout America and the world. Despite being a business that appears to be easily replicated, the company has enjoyed surprisingly good margins (approaching 20% on average) and returns (5-year ROE > 12%), beating up on its primary competitor, Playboy Enterprises (PLA).

Despite this, the company appears to trade at a substantial discount. New Frontier’s market cap is just $38 million, while the company has earned operating income far in excess of that in the last four years alone, even after including a $12 million goodwill write-down that caused the company’s 2009 net income to be negative. In addition, the company has $15 million of cash against just $3 million of debt.

The future is not without challenges, however. As consolidation in the cable industry throughout the United States has taken place, New Frontier’s customers have become more concentrated and powerful. As a result, New Frontier’s business would take a substantial hit if one of these operators switched to a different provider. More immediately, however, this has allowed the cable operators to push New Frontier on price, reducing domestic margins.

Furthermore, while the company’s founder Michael Weiner (which could also pass for a screen-name in this business) is still the chief executive, his annual salary and bonus dwarf his stock ownership in the company, which doesn’t say a lot for the company’s incentive structure. Nevertheless, the company has succeeded for years with Weiner at the helm, and shareholders appear to be offered a price at this level with a substantial margin of safety.

[Full Disclosure: I do not have a holding in NOOF. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. Do your own research before investing in any security.]

Century Casinos, Inc. is a new holding for me. Following is a condensed version of how I valued the business’ assets and was able to find the existence of significant value after a margin of safety was applied without the need of adding its positive “owner earnings” year over year.

Much of the value of Century Casinos, Inc. is tangible in the form of Cash and their Property. I first valued their Property by obtaining the most recent Property Assessments of where each of their Properties reside. Incidentally, these Properties are 100% owned by Century.

At this point, a few questions need to be asked concerning the justification of the Properties values.

Q: How do we know these prices are relevant to the value that could be realized on the open market?

A: A quick scan of various real-estate websites reveal that, in every location of these properties, similar buildings are being offered for sale in excess of their Assessed values and nearly every relative property that sold did so for at least its assessed value.

Note: It would be impossible to make available this information due to its length, therefore I’m leaving it up to the individual investor to come to his own conclusion. The providing of the source is sufficient for you to carry on your research.

Q: What does the Assessed Value include?

A: The structural building and land. It does not include property such as slot machines and gaming tables that are within the casino.

Q: What is not included in this Valuation?

A: Century Casinos, Inc. 33% ownership in a Polish Casino chain. It was nearly impossible for me to value those assets because the Polish commercial real-estate market is not within my circle of competence. However, I did come to the conclusion that the value Century places on their books concerning this property is most likely correct. That value represents an additional $2+ Million. I also did not add the value of the 4 luxury cruise ships in which Century does not directly own the cruise ships itself but does own the rights to have an operating casino on those cruise ships. All of the cruise ships are very similar and I found through discovery that until recently they had operations on 5 cruise ships. They recently sold their rights on one of the cruise ships for more than $1 Million. These items are all “sugar on top of it” and I’ve elected to not include their values regarding this write up for simplicity sake.

Back to the Properties of this discussion:

The four casinos own, collectively, 2,150 Slot Machines. A new casino grade slot machine costs between $9,000 – $12,000 per slot machine. They have a lifespan on average of 7 years before they need to be upgraded, repaired, or completely replaced. On the open market, the average price of a repaired used casino grade slot machine sells for $1,000.

2,150 Slot Machines x $1,000 = $2,150,000

In addition, Century owns all 154 of the slot machines used for their luxury liner casino operations but to keep with my condensed valuation, I am not adding their appraisals to this valuation nor have I included the 90 table games that Century owns.

Property Asset Value: $82,103,059.96

Q: Is the reported Book Value ($88.24 Million)of Century Casinos PPE reliable?

A: It certainly seems so.

Other Assets: Century Casino has $25.49M of Cash on hand ($11.5M not deducted on recent 10-K for the acquisition in Calgary.

Property + Cash Value: $107,595,060

Not taking into account the value of Inventory, Recievables, or any other tangible assets that could be readily liquidated and turned into cash – we can form our decision from this basis alone.
Century Casino currently owes $27.02 Million in Total Liabilities.

$107,595,060 – $27,020,000 = $80,575,060

As of today, April 13th, 2010, Century Casinos, Inc. is selling for $59.52 Million.

Not taking into consideration the excess cash Century generates or the additional asset values, I believe an investment in Century Casino is more than justified.

[Full Disclosure: I do not hold CNTY. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. Do your own research before investing in any security.]